Eric Harrington – The Private Sector Caused the Crash!

There have been recent claims that McCain and the Republican congress heroically tried to stop the mortgage crisis, in a vote to regulate Fannie Mae. The bill was created to reform accounting practices in response to the discovery that “Fannie Mae employees deliberately and intentionally manipulated financial reports to hit earnings targets in order to trigger bonuses for senior executives.” (John McCain, R-AZ) The bill failed for numerous reasons, but the suggestion that it’s intent had anything to do with curbing the housing bubble (nearing it’s peak in 2005 when the bill was created) is compete and utter nonsense. The facts paint quite a different picture.

Yes, the Democrats tried to do a noble thing with Fannie Mae; create a system by which the Government would help mitigate some of the risk (to issuing banks) of sub-prime mortgages for low-income and minority buyers. This was not permission to write bad loans, only help make the interest rates of these risky loans more affordable. But as always, the “Free Market” (i.e. the greed market) kicked in and found a way to use a noble cause to get richer at our expense and ultimately crash our economy..

The first step was to roughly duplicate the Fannie Mae model by packaging of sub-prime mortgages into securities, but instead of selling them to Fannie Mae the investment banks sold them to private investors. After the dot com crash in 2000 the private sector flocked to these “low risk” mortgage-backed securities. Problem is, they were no longer low-risk. Why? Because as the banks realized they could sell off the loans as soon as they wrote them (effectively mitigating ALL risk to themselves and becoming just a middle man,) and with no risk and tons of offshore money itching for the securities they began to relax the underwriting standards to create more loans to feed the huge demand.

First, no income verification (No-Doc) loans were made available to lower credit scores. Next it was No-down payment, (using second mortgages to cover the down) and that was the kiss of death, for eliminating the down payment requirement also eliminated any real financial risk to the borrower (with the exception of their credit score.) What did the banks care? They didn’t even own the loans after the first day — they were sold to some sucker off-shore. Even the rating agencies played along (criminally) and never told the buyers that the risk profiles of the securities had changed dramatically. And this was the actual CAUSE of the bubble. Loan underwriting that eliminated any significant financial risk to the borrower OR the initiating bank.

Now as for government culpability, the Republican administration and congress could have stopped this housing frenzy in a heartbeat. They didn’t need a congressional bill. The easiest way would have been for Alan Greenspan to simply raise the interest rate when he saw the bubble starting. That is his JOB. Reel in an inflationary economy. What is more inflationary than housing prices rising 50% every 2 years? Every real economist knew it was a bubble as early as 2003. Just add 2 points to the prime rate and Poof! No more bubble. Unfortunately for the U.S., and the world, none of those responsible for regulating and monitoring the economy did anything whatsoever to slow or stop the bubble. Why? I am personally of the opinion that the bubble was allowed to flourish to keep the electorate’s mind on their home remodel, and off of Iraq, Katrina, and all the other fiasco’s that in worse financial times would have fueled real anger. And it worked well….

The failed Fannie Mae senate bill previously mentioned would have done absolutely nothing to stop or even retard the housing bubble. Any suggestion to the contrary is pure partisan propaganda, or wishful thinking. The following statistics say it all.

By 2006:
Only ONE of the top Twenty-Five Subprime lenders was directly subject to the housing law (re:Fannie Mae) instituted under Clinton and criticized now by conservatives.

More than 84 percent of the Subprime mortgages in 2006 were issued by PRIVATE lending institutions and had nothing to do with Fannie Mae or Freddie Mac. (In 2004 it was 52 %.)

The article goes on to say:

“The turmoil in financial markets clearly was triggered by a dramatic weakening of underwriting standards for U.S. Subprime mortgages, beginning in late 2004 and extending into 2007,” the President’s Working Group on Financial Markets reported Friday.

The important thing to remember here is that Fannie and Freddie do not underwrite the subprime mortgages they hold; they only “securitize” them. Nor do they do create the underwriting standards for those mortgages; that is the province of the Mortgage Banks we are now bailing out.